Analysis

A Third Election Cycle Can Only Be Bad News for Israel's Economy

Amid political deadlock, Moody's report warns of deteriorating fiscal situation

Campaign posters over the Ayalon Highway for Yamina and the Democratic Union, September 9, 2019.
Tomer Appelbaum

“A third election next year would be a disaster,” Finance Minister Moshe Kahlon said last week. The first two elections have caused a near paralysis of government, which has had a social, economic and political impact, he said, and that will only grow worse if the election cycle is extended another few months.

Every election causes government undertakings to stop dead in their tracks and disrupt the day-to-day work of ministries and authorities. It’s difficult to say exactly what the cost is. There are the hundreds of millions of shekels the government spends to hold an election and subsidize the parties.

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To that, you have to add the loss of economic output for the Election Day holiday, which is usually put at 1 billion shekels ($290 million). The coalition agreements needed to form a new government can add considerably more.

But there is potentially a lot more at stake, in this instance the failure of the government to address Israel’s ballooning budget deficit.

The international credit rating companies have until now taken the view that after the first election, and again after the second election, that a government would be formed and it would deal with the problem. However, two weeks ago Moody’s began expressing concern about the lack of a clear outcome from the September vote and the risk of prolonged political uncertainty.

This week, the agency published its periodic update on the Israeli economy where it again said it expected the next government to respect fiscal responsibility and reduce the deficit. However, “the failure to form a new government, or the formation of a disparate coalition unable to command the internal consensus needed to advance new fiscal measures, would present a risk to Israel’s credit profile,” it warned.

Free fall.

“The ability and willingness of the next government to address the difficult fiscal trajectory in a timely manner, such that the material debt reduction gains over the past decade are broadly preserved, will be an important driver of our assessment of the sovereign credit profile,” the analysts, led by Evan Wohlmann, write.

Its analysts go on to explain that the rating will be by the ability and willingness of the next government to deal with the problematic fiscal path Israel is on and prevent public debt from increasing. The report doesn’t specifically address the implications of the government’s raising its deficit target over the next few years as is widely expected to happen. Meanwhile, however, Moody’s expects the deficit to reach 4% of gross domestic product this year. In the 12 months through August it was 3.8% It also expects debt to GDP to grow from 61% at the end of 2018 to 62% at the end of this year and 62.8% at the end of 2020.

Unless the next government passes a 2020 budget by December 31 – a distant prospect even before the September election – the government will continue along 2019 spending lines on a month-by-month basis, linked to inflation.

Moody’s stresses that this will have the effect of paring back spending to a degree, but the income side of the ledger is another story. The 2019 budget was based on tax and fee revenues of 323.1 billion shekels ($95.3 billion at current exchange rates. That represented a 5.5% increase over 2018 collections before inflation, but in practice the increase has been just 2.2%.

Delaying passage of the 2020 budget threatens to create tensions. The defense establishment and Chief of Staff Aviv Kochavi want to ensure that the broad outlines of its spending are locked in for the coming years so it can better plan. The health care system is seeking a big increase in its budget to deal with crowded hospitals and allowances for the disabled. Doctors, teachers and other public sector workers want to open talks for new collective labor agreements.

Then there is the problem of funding programs that received budgets only for 2019. Unless treasury officials can come up with a plan, these programs will all come to an abrupt halt on December 31.

Those include 1.5 billion shekels of exemptions of customs and the purchase tax for consumer goods like clothing, home appliances and cellphones. The treasury will be under a lot of pressure by the retail industry and others. The expiry will mean sudden price rises. Another program under budgetary threat is summer school camps for first, second and third graders, the enlarged negative income tax program and the Mechir Lemishtaken for helping home buyers.

Legally, the treasury is very restrained from extending the program because we are in an election period. Nevertheless, it is likely to try to employ creative legal tactics. Last June, for instance, the cabinet extended school afternoon programs and other undertaking, it succeeded in getting the approval of the treasury’s legal adviser Asi Messing.

In the meantime, Moody’s concerns haven’t hurt Israel’s credit rating, which remains at A1 – the equivalent of A-plus at Standard & Poor’s and Fitch. Moody’s outlook also remains unchanged at Positive, meaning Israel’s rating could rise further under the right conditions.

Fiscal concerns aside, Moody’s remains positive on the Israeli economy overall: It sees GDP growing 3.1% this year, accelerating to 3.3% in 2020 thanks to Leviathan gas exports. “ While the heightened domestic political uncertainty has so far not had an adverse impact on Israel’s economy, a shift to a tighter fiscal policy could present headwinds to growth next year, with the effects depending on the timing and composition of any adjustment measures,” Moody’s warned.